Nortech Systems Incorporated (NASDAQ:NSYS) Q2 2023 Earnings Call Transcript

Nortech Systems Incorporated (NASDAQ:NSYS) Q2 2023 Earnings Call Transcript August 13, 2023

Operator: Good afternoon, ladies and gentlemen, and welcome to the Nortech Systems’ Second Quarter 2023 Earnings Conference Call. With me on the line today are Jay Miller, President and Chief Executive Officer; and Alan Nordstrom, Acting Chief Financial Officer. [Operator Instructions] At this time, it is my pleasure to turn the call over to Alan Nordstrom.

Alan Nordstrom: Thank you, Holly. I’d like to welcome everyone to today’s conference call. Jay will begin this call with a review of our business, current trends and several strategic initiatives. Then I will review Nortech’s Q2 2023 financial results before turning it back over to Jay for his closing comments. Then we’ll open up the call for your questions. So before we continue, please note that statements made during this call and Q&A session may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include expected revenue, gross profit, gross margin, EBITDA, free cash flow, net income, financial performance, future plans, developing technologies, opportunities and other company expectations.

These estimates, plans and other forward-looking statements involve unknown and known risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks, including those that are detailed in our most recent Form 10-K and most recent Form 10-Q filed with the SEC, may be amended or supplemented. These statements made during this conference call are based upon information known by Nortech as of the date and time of this call, and we assume no obligation to update the information in today’s call. You can find Nortech’s complete safe harbor statements in our SEC filings. With that, I’ll turn it over to Jay for his opening comments.

Jay Miller: Thank you, Alan, and good afternoon, everyone. We appreciate you joining us. I know we have some employees listening in as well, and I’d like to start off my remarks by thanking all of our global Nortech team members. I’m very proud to lead such a dedicated team here in Minnesota as well as in Mexico and China, committed to serving our customers during difficult times like the global pandemic and subsequent supply chain disruptions. While both of these specific situations have improved significantly, we know that Nortech must always be prepared to face tomorrow’s challenges. I have confidence in our team members’ willingness and ability to consistently deliver outstanding performance that helps differentiate Nortech from our competition.

Also on behalf of the entire Nortech team, I want to express appreciation for Nortech’s many supplier partners who work closely with us as we serve our mission-critical medical, industrial and defense customers. We truly could not do our jobs without these strong relationships with our supplier partners. Right at the beginning, please note these key takeaways from this call. Our bookings remained very strong, and our backlog is continuing to climb. Revenue continues to grow and our profitability is growing even faster. In fact, over the previous 10 quarters, last 12-month revenue has grown by over 40%. Meanwhile, our last 12-month gross profit adjusted for onetime events has nearly tripled and our adjusted gross margin percentage has roughly doubled.

Most importantly, our last 12-month adjusted EBITDA has improved by over $9 million from a negative $2.3 million to a positive $6.8 million. Humbly, we have to admit that’s a pretty amazing trend. Turning now more specifically to our second quarter performance. We continue to achieve solid results in revenue, EBITDA, bookings and backlog, even over a strong prior year comparisons. Bookings came in at the highest level in the past four quarters at $37 million. Our total backlog topped $100 million, which continues to surpass our expectations as the post pandemic and supply chain crisis market is stabilizing. With strong bookings, we are resetting our expectations back to steady backlog growth sooner than we had anticipated. This, of course, is great news.

In recent quarters, when supply chain challenges were more acute, certain customers ordered parts ahead, which meant that we shipped more in those quarters than we would have otherwise. Now those customers are working down their inventories, which means we shipped a little less in the second quarter generally than we would have otherwise. History indicates that these factors tend to balance out, and we are guardedly optimistic that the pendulum is starting to swing back Looking ahead at the rest of 2023, our positive results at the halfway mark support the upbeat outlook that our large customers, in particular, are communicating. They are expecting a pretty solid year with an outlook I would characterize as cautiously optimistic. One major customer recently cited increasing global demand as the key driver of their revenue increase.

Beyond 2023, there is still some shared uncertainty about next year, including wondering what a possible recession might look like and how long it could last. However, recent macroeconomic news is encouraging, such as sustained labor market strength and easing inflation. This news has influenced higher GDP predictions for the remainder of 2023 by some economists and the economy seems on track for a relatively soft landing. In this dynamic global economy and industry, Nortech’s relatively small size compared to much larger EMS firms can be an advantage. We are more nimble and better able to adjust more quickly to changing conditions and market forces. I’ll conclude my opening comments with 2 examples of Nortech’s agility and prudent approach.

First, strategic innovation. To stay ahead of market trends and better serve our customers, we are carefully investing in new technologies that can differentiate Nortech and provide a competitive advantage. Two examples include the Active Optical Xtreme and Flex Faraday Xtreme platforms. To help foster innovation like this, Nortech established the Science and Technology Committee of our Board several years ago. The existing of this Board committee makes Nortech somewhat unique. Indeed, just 56 Fortune 500 companies have such committees according to a Wall Street Journal article in May of 2023. It was gratifying to be included in this article with Nortech recognized for our focus on innovation and its impact on winning new business. The article noted that Nortech stock price had more than doubled in the past three years, far exceeding the 44% gain of the S&P 500.Second, Nortech is committed to being a better steward of our planet.

As I mentioned on our last call, we are proactively steering our focus on environmental, social and governance, or ESG objectives. In our initial baseline steps, our U.S. plants are initiating measurement of Nortech’s Scope 1 and Scope 2 emissions, which encompass both direct emissions and indirect emissions from energy repurchase. While focusing on our planet’s long-term future through ESG efforts and the long-term value of Nortech, we simultaneously remain committed to optimizing quarterly financial returns for our shareholders. We firmly believe that these objectives can coexist and also mutually enhance each other. We also expect that aligning with ESG goals will become increasingly crucial for business in our chosen markets. Before I hand the call back off to Alan for our financial review, I should mention that our search for Nortech’s next Chief Financial Officer is underway.

We believe we are in a good position right now with our financial reporting structure and procedures in place. Alan is filling the interim CFO role very capably, and the finance and accounting team is operating at a very high level. We are taking the necessary time to make the right hire, realizing that the next CFO will play a vital role in supporting our growth plans. Now for more in-depth financial discussion, I’ll turn the call back over to Alan.

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Alan Nordstrom: Thank you, Jay, and thanks, everyone, for joining us today. In the next few minutes, I’ll provide certain details of our financial performance in the 2023 second quarter, but I would encourage you to review our latest Form 10-Q, which we filed earlier as it contains far more information about our business operations and financial performance than we will cover on this call. Before I begin our financial review, I’d like to take a minute to again highlight the new chart we added to our press release last quarter and which we will include each quarter going forward. It provides 10 quarters of LTM over the last 12 months, historical data for four key metrics: sales, gross profit dollars, gross margin percent and EBITDA.

As we have pointed out in the past, we believe that our individual quarters can be affected by outside factors. These might include timing fluctuations, customer shipments and supply chain issues. Any of these during a given reporting cycle could temporarily disrupt our momentum. Consequently, we believe it is more appropriate to review our business on a longer-term 12-month basis rather than a strict calendar year. This approach will help normalize these potential anomalies and offer a better gauge of our company’s long-term success. So switching to our second quarter financial performance. As Jay noted, we made progress in several key performance areas with quarterly revenue up nearly 8% from the prior year period. Again, we’re particularly pleased by this revenue momentum as this quarter’s year-over-year growth continues to come on a strong prior year comparable.

We also saw sustained year-over-year backlog levels, increases in the year-over-year gross margin and solid levels of net income and EBITDA. Over the past several quarters, we have taken necessary steps to create a firm financial platform that can be flexible and respond quickly to changing macroeconomic conditions. While we are constantly vigilant to the negative impacts of inflation, we are encouraged as our customers are reporting fewer supply chain disruptions, and we are more optimistic given the continued sales momentum we saw in the second quarter. Evidence of this renewed sense of optimism can be found in our total backlog level last quarter and our new record level of bookings. Total backlog continues to exceed $100 million. Coupled with the strong bookings levels and our solid foundation, we are confident that we can maintain momentum into the second half of the year.

Increased shipments during the quarter resulted in orders moving through the pipeline quicker and causing backlog levels to start reaching a steady state. In the near term, we expect backlog levels to remain relatively constant with future growth coming from accelerated contributions from both new and existing customers as well as technology innovations. In the balance of my comments, I’ll review key areas which drove our second quarter financial performance. They include: First, a review of certain factors impacting our income statement; second, selected items, which influenced Nortech’s cash flow statement; and lastly, a brief review of the balance sheet. As usual, if you have specific questions about these items or any of our quarterly financial results, I’ll be happy to address them during the Q&A portion of this afternoon’s call.

In Q2 2023, near record revenue totaled $35 million. This represents a $7.7 million increase from revenue of $32.5 million in the second quarter of 2022 and was up slightly from the prior quarter, which increased with increases coming from higher volume and previous pricing actions. Again, this performance was particularly noteworthy as it compares to a strong performance in the prior year period. In fact, we’ve been able to sustain revenue growth over the trailing 12-month period despite the stronger historical comparables. Nortech second quarter 2023 revenue performance was driven by growth in our medical as well as our aerospace and defense categories. In the second quarter, the medical market was up $2.1 million or 11.2% as compared to 2022 with the majority of the increase caring for medical component products.

In the second quarter, revenue from the aerospace and events market was up $829,000 or 18% from the prior year. Included in the financial performance for the current year, gross profit totaled $5.5 million or 15.6% compared to gross profit of $5 million or 15.4% in the prior year quarter. Second quarter 2023 operating expenses totaled $4.4 million, a 10% increase from the second quarter of 2022 operating expenses of $4 million and flat on a sequential basis. The $396,000 increase in year-over-year operating expenses, driven primarily by a $437,000 increase in second quarter general and administrative expenses from the prior year quarter. The majority of the increase in year-over-year G&A costs were due to higher professional fees and increased labor costs.

Finally, we had a reduction of $34,000 in the year-over-year research and development costs. We believe that this level of investment was sufficient to support new technologies such as the AOX scalable platform and the Flex Faraday Xtreme technology. As a result of our performance in the second quarter of 2023, net income totaled $635,000 or $0.22 per diluted share, in line with the prior quarter and second quarter of 2022. Through the first half of 2023, net income totaled $1.3 million versus $857,000 in the prior year first half. Also, all employee retention credits or ERC, have been received as of June 30, 2023, and our balance sheet and cash flow statements reflect that. Next, in the second quarter of 2023, net cash used by operating activities was $1.4 million.

Receivables at June 30, 2023 were $17.4 million, up from receivables of $16.2 million in the prior quarter and $16 million at year-end. This is in line with the seasonal pattern that we’ve seen evolve over the past couple of years. The first half of the year has been typically marked by higher receivable levels while cash collections accelerated during the summer months and second half receivable levels declined. During the second quarter, increased shipments as well as less pressure to respond to global supply chain shortages, capital inventory levels at $21.1 million, relatively flat to quarter levels and down from $22.4 million at December 31, 2022. We ended the second quarter of 2023 with a $5.3 million of borrowing capacity on our $16 million line of credit for Bank of America.

This credit agreement is important in giving Nortech the flexibility to manage through the headwinds we have experienced in the last few years and the previously mentioned seasonal fluctuations we see in our receivables balances and collections. At June 30, 2023, cash and equivalents totaled $1.9 million, down from $2.5 million at the end of the prior year. However, we believe that our existing financing arrangements, anticipated cash flows from operations and cash on hand will be sufficient to satisfy our working capital needs in 2023 as well as any capital expenditures and debt repayments. We are confident that we have created a solid financial base to take this company into the future. On a final note, let me reiterate that our top financial priorities for 2023 remain unchanged.

First, we are extremely focused on continuing to strengthen our balance sheet and mitigate impacts we may see from changes in the economic environment or seasonality. Now, we will take further advantage of opportunities to align our operations and infrastructure with the market demand that we are seeing in order to deliver sustainable free cash flow growth. Our confidence in results from the growth momentum we saw in 2022 that has sustained thus far in 2023. Coupled with disciplined lean operation execution and R&D innovation, we believe Nortech can deliver on our objectives. With that, I’ll turn the back over to Jay for closing comments.

Jay Miller: Thanks, Alan. Early in this call, I mentioned our efforts around two key initiatives, innovation and ESG. I’ll conclude my remarks by citing these other initiatives. The Internet of Things or IoT and artificial intelligence or AI. We know there are opportunities for Nortech to leverage IoT and AI applications to enhance our services, efficiency and financial scalability. While ChatGPT is getting most of the media headlines, AI and machine learning and IoT have actually been around for a number of years. But the opportunities and awareness of IoT and AI potentially are certainly ramping up. As with our ESG approach, we intend to lead and not just follow with IoT and AI. What could IoT and AI implementations look like in Nortech Systems?

We’re in the early stages, but here are some applications our team will be analyzing. From improved quality control, AI and IoT can be leveraged proactively in the detection of manufacturing issues to ensure better product performance and customer satisfaction. For enhanced engineering support, IoT and AI can streamline and design assistance we offer customers for their PCBAs and higher level assemblies, followed by accelerating our production setup. And when future component charges happen, IoT and AI can help us more quickly identify and source substitute parts. By harnessing the potential of IoT and AI, Nortech not only accelerate manufacturing processes and improve product quality, but also expand our services and reinforce Nortech’s competitive advantages.

Finally, before our Q&A session, the key takeaways I noted earlier bear repeating. Our bookings remain very strong, and our backlog has continued to climb. Revenue continues to grow and our profitability has grown even faster. Over the previous 12 — 10 quarters, trailing 12-month revenue has grown by over 40%. Meanwhile, our last 12-month gross profit adjusted for onetime events has nearly tripled and our adjusted gross margin percentage has roughly doubled. Most importantly, our last 12-month adjusted EBITDA has improved by over $9 million from a negative $2.3 million to a positive $6.8 million. We’re very proud of these numbers. That concludes our presentation. And now we’ll open the call up for questions. Operator?

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Q&A Session

Operator: [Operator Instructions] There are no questions in queue.

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Jay Miller: Thank you, Holly, and thanks to everyone for joining us today. We look forward to talking to you next in November with our third quarter 2023 results. Thank you, and goodbye.

Operator: This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.